With incentives, things are not always what they seem

“Most of economics can be summarized in four words: ‘People respond to incentives.’ The rest is commentary,” Steven Landsburg writes on the very first page of The Armchair Economist (perhaps not without a hint of provocation).

He has a point. In fact, the observation stretches well beyond economics as we generally understand it: much of biology and even evolution can be explained on the basis of incentives and disincentives. It is because organisms tend to repeat behaviour that provides them with a benefit, and to avoid behaviour that is disadvantageous that they survive, prosper, procreate, evolve and persist.

But the term ‘commentary’ does a lot of the work in that quote. ‘Incentives’ are often – certainly implicitly – interpreted as material incentives, i.e. money, or the things that are typically bought with money. It is, in a sense, at the heart of the assumption of rationality: if we get more money by doing something, we’ll do more of it (work harder, for example), and if we get less (or need to pay) if we do certain things, we’ll do less of them (committing crime, say).

Immaterial drivers

In practice, we are often motivated or discouraged by other drivers than material (dis)incentives, of course, and that is certainly part of the commentary. A sense of duty may stimulate us to volunteer or donate to charity, friendship may make us help a friend move house, and guilt aversion, rather than the fear of punishment, may prevent us taking advantage of a colleague’s purse being unattended on her desk. We may buy products of a ‘trusted’ brand, one that we are ‘loyal’ too rather than buy a much cheaper, but otherwise mostly equivalent, alternative from a German discounter. All this is really comprised in Landsburg’s commentary.

Yet it can be interesting to distinguish between material incentives and immaterial influences on our choices. A famous and often quoted example of the remarkable interaction between the two is found in a paper by the economists Uri Gneezy and Aldo Rustichini, A fine is a price. They performed a field study in 10 day-care centres, where on average about 6% of pickups were up to 30 minutes late. There was no cost to being late, so the 94% timely pickups were obviously not motivated by a material incentive. The authors then introduced a fine in some of the locations, and found that in those centres the number of late pickups did not diminish, but instead roughly doubled. One explanation is that any original guilt of being responsible for a carer to stay late was crowded out by the payment of a fine. For some of the parents this was clearly a superior deal.

Some employers looking for staff offer incentives to their employees, encouraging people from their social networks to apply for jobs. This approach is motivated by the belief that such candidates tend to fit better, are of higher quality, and stay longer. An important side effect is that the cost of recruiting in this way is lower too. Overall this appears to be a win-win-win arrangement. Aside from the benefits to the employer, the existing employee gets a cool bonus – which can be as high as a few thousands of dollars, euros or pounds – and the new recruit gets a great job.

Could a similar incentive work the other way around – i.e. if you’re looking for a job, would it make sense to incentivize the people in your network to introduce you to their own employers (or potential employers in their network)? At first sight, commentary-less incentives would seem to make it, at least in principle, a workable proposition. A quick word with HR, or with the recruiting manager of a suitable department on behalf of your friend is such a small effort, that even the smallest compensation would vastly outweigh it, even the chance of success is low. (And anyone lucky enough to have an employer with an employee referral scheme may even benefit twice.)

But when we also look at the commentary, a different picture might emerge. Referring a friend or an acquaintance to a prospective employer is in the first place a favour, inspired by immaterial, social motives rather than material ones.

Material dominance?

That does not necessarily mean an additional material incentive might not boost that motivation, especially in the area of employment. Most of us choose to work where we work, and do what we do, as a result of both kinds of motives. We always face a trade-off, even if we are not entirely conscious of it: often we could earn more, but that would mean doing a job that is not as pleasant or rewarding as our current one. Likewise, we can envisage more appealing work, but it would not pay as much as we earn now. And still, between two jobs that are similar in all other respects, most of us would choose the one that pays more.

It is not obvious how that material element would translate to the favour of helping someone find a new job, though. Imagine the amount on offer is small but not insignificant, say £50 or $50 – a nice extra for the referrer. But compared to the referral bonuses employers pay it is pitiful. It would be like asking a friend to spend a weekend helping you move house in return for £50. There are things we would do for free as a favour, or at a proper market rate, but not for something in between. Yet even an incentive comparable to an employer’s bonus might backfire. Leaving aside whether it would make economic sense to pay a friend £2,000 if their referral led to your finding a new job, they might question your friendship: do you really believe they would need that kind of incentive for what is really a favour between friends?

Interestingly, even in conventional employee referral schemes the bonus on offer is probably not the principal motivator, Laszlo Bock, Google’s former Senior VP of People Operations, says. People refer their friends because they like working for their company, not because they’re after a bonus.

Steven Landsburg’s observation is a fine heuristic for understanding and influencing people’s behaviour. But when you wonder whether material incentives are the best way to make people respond, don’t forget to check the commentary.